• Sat. May 25th, 2024

North East Connected

Hopping Across The North East From Hub To Hub

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By Ritchie Clapson CEng MIStructE, co-founder of propertyCEO  

Many people are eyeing small-scale property development opportunities (where small commercial buildings and shops are converted into much-needed residential accommodation), but there’s nearly always an elephant in the room: property development can make you rich, but it’s inherently risky. It’s easy to imagine glitzy new apartments and six-figure profits, but if you don’t manage the risk in development, those swanky dwellings and huge returns may not materialise. Managing risk is arguably the most important task of any developer worth their salt, new or otherwise. So, how should you go about it?

Cards on the table – there’s always risk

There’s no way of de-risking property development completely. Just like most wealth-generating enterprises, it’s a strict risk-versus-reward model. And one of its biggest challenges is that the barriers to entry are minimal. After all, anyone can develop property by buying a property or some land and then hiring various professionals such as architects and builders to get to work. What could go wrong, they think? Well, the answer they’re looking for is ‘quite a lot’, as many first-time developers subsequently discover.

So, if you’ve ever fancied trying your hand at a spot of property development, let me share a few tips that should help you avoid some of the bigger boulders that lie in your path. There are quite a few smaller ones too, but for now, let’s stick to the whoppers. The good news is that small-scale development is well within the reach of most people, and with some basic risk mitigation in place, the process is likely to be more profitable and successful.

The planning risks

If you’re developing property, whether a new build or simply converting an existing building, you’ll need planning permission. Try building anything without it, and you risk having to knock it down, being fined, or even imprisonment, so obtaining permission isn’t exactly optional.

The current planning infrastructure originated in the 1950s, and today we’re faced with local planning authorities that are under-resourced, over-stretched, demotivated, and where many of the most experienced people have left. Planning applications that should nominally be assessed within eight weeks (thirteen weeks for larger projects), nearly always take much longer.

These days applicants are frequently told seven and a half weeks down the line that they need to submit further information, e.g., by procuring various surveys and reports. This stops the clock, and you now need to spend more time and money jumping through some hoops with no guarantee of a successful outcome. Some applications have been in limbo for years. And if you’ve already purchased the property in the hope of getting planning permission, you’ll not only be racking up finance costs while you wait, but the property may also even go down in value if planning is eventually refused.

So, how can you dodge the planning bullet? The answer is to avoid as much of the planning system as possible. Helpfully, the government has given us a tool for the job called Permitted Development Rights (PDRs). These rights allow us to change a wide variety of commercial buildings into residential use without having to apply for full planning permission. In most cases, we’ll still need council approval, however with PDR’s there is a short and prescriptive list of things they can object to. So, you know what boxes you need to tick beforehand, plus the council must determine the application within eight weeks, otherwise it automatically gets approved. You’ll still need full planning permission if you’re changing the elevations of the building, but that shouldn’t be contentious – the change of use is the important one, and with PDRs, the council’s hands are effectively tied.

Not all PDRs are created equal; my favourites are classes G and MA which allow us to convert most commercial property types (offices, shops, light industrial, etc.) into residential. Why do PDRs exist? The government has realised we have around four years’ worth of new homes that could be built on redundant brownfield sites. And given that most voters won’t object to developers turning unused commercial buildings into much-needed housing, they’ve been quick to encourage it. So, if you’re looking to de-risk your first project, I would strongly advise you to go down the Permitted Development route as it’s likely to be quicker and more certain.

What if you bought a property that already has planning permission granted – won’t you avoid the planning risk? The problem with this approach is that the planning uplift has already been built into the asking price, meaning there’s less profit for you. As a result, the successful bidder will be the person who will either build it the cheapest, make the least profit, or make a loss because they’ve got their numbers wrong. None of these options should appeal to you. Even if you think you could improve on the existing plans, you’re still back to square one – having to submit a new planning application that may or may not get approved. So, I would avoid these schemes, no matter how appealing the artist’s impression looks in the agent’s particulars.

The optimism risks

You may tell yourself that you’re far too old and wise to fall into the trap of making optimistic assumptions, but the problem is you won’t necessarily notice that you’ve done it. There’s no reward in finding unprofitable deals, so we’re predisposed to hope that every deal we look at will be profitable. There are a lot of variables that determine whether a deal works financially, and you need to make a lot of assumptions, certainly at the outset. If you dial every cost assumption to the minimum, your numbers will project a hefty profit. Dial costs to the maximum, and you’ll show a loss. The trick, then, is to be as pragmatic as possible. Don’t fall into the trap of being just a tad optimistic here and there, as it can really trip you up.

Also, ensure you can’t see your overall profit percentage figure when you input your assumptions. If you can, then as you see your profit percentage figure reduce, there’s a high risk that your subconscious will make your assumptions less prudent – it’s human nature. The solution is to input every assumption reasonably and only enter your target sale values (GDVs) afterwards. That way, you’ll only see your profit percentage AFTER inputting your cost assumptions.

The margin risks 

My next piece of de-risking advice is always to target a 20% profit margin based on GDV (gross development value, i.e., your selling prices). So, if your units are expected to sell for a total of £500k, you want to target a £100k profit at the outset. You should also include a contingency budget of 10-15% of the construction costs. This lies at the heart of development risk management. You won’t be able to predict the additional costs that will crop up as your project progresses, so you need to build in enough fat to ride out a few storms. And there will be bumps in the road; the trick is to ensure you’re still left with a decent profit once you’ve crossed the finish line.

Also, don’t be tempted to target a fixed profit figure rather than a percentage. For example, you might think that targeting a £200k profit sounds pretty good. But if the GDV were £5m, you’d only make a 4% profit margin. It doesn’t take too many unexpected costs to wipe out 4%, so make sure that you stick to 20%, not simply a fixed amount of money you’d like to make. While we’re talking about numbers, make sure you’ve firmed up as many of your pricing assumptions as possible before you commit. You won’t be able to fix them completely, but a common mistake is leaving too many figures as ‘reasonable assumptions’, then getting lazy and assuming that your initial assumptions will be about right. Instead, firm up as many of your numbers as possible before you commit, and you’ll reduce the risk of expensive surprises later.

On-site risks

Problem often occur when people fail to specify what they want precisely enough. Say you’ve specified ’a dozen internal doors’ in the tender and imagined those rather nice oak ones with brushed aluminium handles. And then, when your contractor installs cheap-as-chips plywood doors, you’re up in arms. No problem, says your contractor; they’re happy to change them, but it’ll cost you a few grand more. The lesson? If you don’t specify what you want precisely enough, your contractor will likely install the cheapest available, so be very specific.

The exit risk

My final piece of de-risking advice is to have more than one exit for your project at the outset. You may want to sell your finished units, but what if the market has tanked when you come to sell? The logical thing to do could be to refinance the project onto a buy-to-let mortgage and then let the units out until the market rebounds. On the other hand, if you were planning to rent out the units but the rental market bombed, then your plan B could be to sell. Either way, ensure you’ve worked out a Plan B at the start and that you know the numbers involved.

As I said, property development has many risks, but it’s possible to reduce most of them if you have the right education to learn where they are and the right mindset to have risk mitigation as a primary focus. With so many development opportunities out there at present, if you get that right you’ll be off to a flying start.

ABOUT THE AUTHOR

Ritchie Clapson CEng MIStructE is an established developer, author, industry commentator, and co-founder of leading property development training company propertyCEO. To discover how you can get into property development, visit www.propertyceo.co.uk

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